Shotgun clause variations can protect financially weaker shareholders

By Staff

Variations on a shotgun clause can protect less powerful shareholders in private corporations, says Toronto business lawyer Anton Katz.

Katz, principal of Anton M. Katz Barrister & Solicitor, says a standard shotgun clause in a shareholder agreement is a popular mechanism for ending a business partnership in the event the relationship goes sour.

When invoked, the clause requires one party to present two offers to the remaining shareholders, Katz tells The first offer is to buy the others out of their shares in the company, while the second offer is to sell their own interest, but crucially the share price in both proposals is the same.

The remaining shareholders then have the option of accepting the invoking party’s offer, selling their shares and leaving the corporation.

“Or they can turn the shotgun around, accept the offer to buy the other party’s shares at the same price, and take ownership of the entire company,” Katz says.

All other things being equal, he says the two-way nature of the transaction offers a natural balance, incentivizing the offering party to set a fair price for the shares.

However, when shareholders are mismatched in terms of financial might, Katz says an unaltered shotgun clause can be used by a more powerful party to take advantage of their weaker partner, by pressuring them into a sale that undervalues their holding.

“If you’ve got a million-dollar company, and one party is in severe financial difficulty, then the other party could make them a lowball shotgun offer, say of $50,000 for their half,” he explains. “Even though the shares are worth 10 times that, they know that the offer will have to be accepted because there’s no way the weaker partner could afford to buy the stronger partner out.”

To prevent such a situation from arising, Katz says the shotgun clause could be amended to specify that the offers to buy and sell must be set at fair market value. A valuation requirement could be included as an extra barrier to triggering the clause, he adds.

“Even if the weaker party is unwilling to sell, at least they can be comforted by the fact that they will get a fair price for their shares,” Katz says.

Another simple variation would insert a time lag between the triggering of the shotgun clause and its exercise, for a period of as much as two years.

“The benefit of the delay is it forces the parties to work together to resolve their differences, and it may also give the weaker party the chance to build up their finances, so that they are in a better position to defend against the shotgun when it finally occurs,” Katz says.

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